Boiling oil likely to scald economy

India’s policy managers have been given a wake-up call as the country’s central bank has served notice of the dangers of second round effects arising from high oil prices.

For central banks the world over, battling inflation has been a key concern. With global oil prices on the boil, normally in the first round, consumer prices edge up after the prices of petroleum products become expensive.

However, in some emerging markets like India, the rise in price is not fully passed on to the user. But with oil prices not abating, the pass-through of such price increases is expected to be much higher. When such a pass-through occurs, the authorities would have to contend with higher inflation.

This would also mean looking at the prospect of higher wages and consumer prices, lower corporate earnings, all of which impacts inflation apart from a wider trade deficit. To curb all these second round effects, monetary policy authorities may need to further tighten monetary policy which in turn can have an impact on growth. Clearly, India’s central bank would want to prevent such an occurrence which could threaten to derail the growth story.

Among peers, Brazil opted for a monetary tightening course in ’04 to guard against second round effects. In India, consumers have been protected from high oil prices with controls imposed on pricing for oil refining companies coupled with budget support from the government also.

In its first quarter review of the monetary policy, the Reserve Bank of India made it clear that since the pass through of global oil prices is expected to be higher in the future than before, policy authorities ought to be on guard. This to avoid the occurrence of second round effects.

Besides, to contain year on year inflation rate for ’06-07 in the range of 5 to 5.5 it would warrant priority in policy responses, the central bank said. According to Ajit Ranade, chief economist, AV Birla group, since the global rise in energy prices had not been reflected in petro product prices here, once the pass through happens, it would lead to higher inflation.

“The monetary policy is pre-emptive in moderating inflation “ he said. Subir Gokarn, chief economist, Crisil, the RBI had found the interest level which matches its growth target.